If you are looking for a mortgage to buy a house, you have probably heard the word "points" used. No, they aren't talking about the score of last night's NFL game. Instead, they are talking about a fee that is paid to the lender of the mortgage you are getting to buy your home. Points can have both good and bad effects on your mortgage, so it's important to know how they can help and hurt you before you decide if a mortgage loan is right for you.
In its simplest form, a point is a one-time fee paid to a lender to get a loan with a lower interest rate than the market rate. Each point is equal to 1% of the total mortgage amount. So, if your mortgage is for $150,000, one point is worth $1,500. A seller would pay points on a loan to lower the interest rate, which could save them much more money over the life of the loan than the points cost up front.
Points aren't always paid for by the buyer; sometimes the seller will pay for them instead. When a seller pays for points, it's usually because they need to sell the property quickly or have been having trouble finding buyers. In this case, it is used as an incentive to get the buyer to close on the property.
There are times when buying points might not be the best thing to do. One easy way to do this is to figure out the payback period, which is the amount of time it takes to pay back the points you bought up front. First, figure out how much your monthly payment will be without points. If you pay $900 without points and $800 with them, you save $100 each month. Now, take the total cost of the points, say $3,000 for two points on a $150,000 mortgage, and divide it by the amount you'll save each month. The answer is 30 months. It will take you 30 months to get your $100 per month in savings. If you can afford it, it makes a lot of financial sense to pay the two points up front for a 30-year loan.
When you don't plan to stay in your current home long enough to reach the payoff, you need to be careful with points. You also need to remember that the cost of points is on top of the down payment you make on the house you want to buy. It can add a lot of costs up front, so it's only a good idea if you plan to live in the house for a long time and have a lot of money up front to pay for it.
One last thing about points: because they are like pre-paid interest, they are tax-deductible. Even if the seller pays for them, the buyer can still deduct them. For a new purchase, points can be deducted in full the year they are paid, and for a refinance, they can be deducted over the life of the loan.
